Russia may have more than 1100 banks but the country is still underbanked and its financial sector, which has come a long way since the crisis 10 years ago, remains immature. Long-term finance resources are meagre, banks are highly dependent on foreign funding, institutional investors are thin on the ground and other mechanisms of a developed financial system are notably absent.
Although individual banks in Russia have made enormous strides in improving corporate governance, being more open about their structure of ownership, reducing related-party lending and diversifying funding sources, the financial system as a whole is still a cause for concern. The Central Bank of the Russian Federation’s pro-active stance during the current liquidity crisis has been applauded and has been compared favourably with the response to a similar situation in 2004, but nevertheless, the predicament of the banking system is usually listed as a constraining weakness by rating agencies in their sovereign assessments.
“The key near-term risk for the stability of Russia’s banking system and ultimately the real economy is Russian banks’ significant dependency on external markets for refinancing,” says a Standard & Poor’s report. While Fitch says: “[We] regard the Russian banking system… as a potential weakness to the sovereign rating, due to its rapid growth on relatively unsure foundations; that said, the system’s relatively small size limits the potential sovereign contingent liability.”
Russia’s ratio of banking assets to gross domestic product (GDP) at 56% makes it underbanked with respect to comparable countries such as Ukraine (66%), Kazakhstan (91%), Poland (75%) and Hungary (85%). And the vastness of the country’s foreign reserves means that, even subtracting from them the $147bn in gross banking external liabilities, Russia would still have sufficient to cover nine months of imports.
Serious concerns grow
Leading Russian bankers, however, are becoming increasingly vocal about how the weakness of the sector as a whole and the lack of a proper institutional framework are now holding back development. Ilya Yurov, chairman of the board of directors at Trust National Bank, says: “The domestic banking industry has developed well in terms of products, skills, services and business standards, but we still have general problems, such as a weak base in terms of financial resources. We still do not have an institutional investor class in Russia, we are still quite a dollarised economy.
“The government hasn’t set up refinancing institutions to increase the domestic money supply and so we are dependent on international investors for funding – 40% of the liabilities of the domestic banking industry are foreign debt instruments, such as Eurobonds and syndicated loans. This is the biggest issue for the Russian banking system.”
Mr Yurov characterises Russia as a country with two different payment systems: one is the banking system and the other is the government system. With oil prices at record highs, the coffers of the government and government-linked energy companies, such as Gazprom, are overflowing with money but much of it is being placed abroad or kept within what Mr Yurov calls “the government economy”.
“As an industry, we don’t need fresh cash and we have short-term money but what we don’t have is long-term sources of funding for mortgages, small and medium-sized enterprises (SMEs), start-ups and project finance,” says Mr Yurov. “We have tried to explain to the government that our short-term liquidity is not going to be invested in future growth, with things as they are at present, and that it is not healthy to have 86% of GDP related to 20 companies that are mainly exporters. We need a commercially developed, long-term economic structure, otherwise we will end up with a Venezuelan type of economy.
“Gazprom and Rosneft are important to Russia but they will not diversify their activities. We need to develop a normal economy with companies that are producing goods and services for domestic supply and to increase our rouble cashflow,” he says.
Funding shortfall
Alexander Sobol, deputy chairman of the board at Gazprombank, says that one impact of the credit crisis has been to highlight the lack of long-term funding in Russia. “Western money has been our only source of long-term money. Inside Russia, we don’t have much in the way of long-term funds. Deposits from either retail or corporate depositors are for a maximum of a year or 18 months. Currently, there is a high demand from corporates for investment loans and from ordinary people for mortgages but a lack of long-term funding to meet this demand.
“One of the fundamental causes is that rates of deposit are lower than the level of inflation,” he says.
Retail deposit rates are 9% compared with an inflation rate of 12%. Changes that could be made to improve Russia’s finance and investment sector, according to Mr Sobol, include reforming tax policy to encourage long-term investment and liberalisation of markets for derivatives and securitisation.
Internal resources
“The government is working on these things with the aim of channelling more money domestically,” says Mr Sobol.
Earlier this year, for example, the Stabilisation Fund (FSF), which was set up in 2004 to hold excess oil revenues and to protect the budget against future falls in the oil price, was split into two new funds: the Reserve Fund will act as the original FSF did; and the Fund for National Prosperity (FNP) will be used to recapitalise the state pension system. The Reserve Fund is invested overseas in AAA government and agency bonds and the FNP will be invested in higher yielding securities.
“It should be used for investment inside Russia such as investments in infrastructure,” says Mr Sobol. “Currently, pension funds are very conservative and only invest in state or foreign obligations. They need to invest in the Russian private sector, providing long-term funds and receiving higher returns for pensioners in the process.”
Yet for all the concerns about the development of the Russian financial system, for many banks these are boom times. Alexander Zakhariv, head of equities at Metropol Investment Financial Company, says: “Things have improved tremendously, with more Russian money coming into the market. We have more retail investors and more mutual funds, and a general feeling of stability. Previously, when there was a crisis, people would move their money outside of Russia immediately.”
Raising profile
Metropol, KIT Finance and Otkritie are among a number of Russian investment banks that have gained higher profile in recent years even though they are still some way behind the market leaders: Renaissance Capital and Troika Dialog. KIT and Metropol have excelled in mergers and acquisitions (M&A) based on utility sector transactions, while Otkritie is among the top five Russian equity brokers by trading volume.
However, whereas the original aim for owners of Russian banks was to sell out to a foreign investor, Otkritie chief executive Vadim Belyaev thinks that the opportunities in Russia are now so immense that this has become a less appealing prospect. “The original idea was to start a business and then sell out as Aton did [Aton sold out to Bank Austria Creditanstalt, which is now owned by UniCredit],” he says. “Now the world has changed. The leaders of this business have too much to lose right now [by selling out].
“A lot of small and medium-sized companies in Russia are planning to go public and this will be a huge opportunity for investment banks. And it is not a business that is so attractive to the international investment banks, which, in any case, have their own problems. Three to five years ago, a bank such as Renaissance would have been an obvious target for a foreign bank but now it looks as if Renaissance could become a global player in its own right.”
Exciting segments
SMEs, project finance and all things retail are exciting areas for Russian banks as they move away from relying on lending to blue chips as well as the cosiness of a position inside a financial-industrial group.
Nomos Bank was never part of a financial industrial group. It was started from scratch by a group of Russian businessmen. In keeping with the trend among leading Russian banks for increased transparency, Nomos now provides a complete breakdown of its shareholding structure in its investor presentations, including the names of private individuals, their share of the capital and their voting stock. It also details the relationship with PPF Group, the Czech financial group that now holds a 49% stake in Nomos.
PPF is the group behind Russia-based consumer finance company Home Credit and Finance Bank as well as the insurance and pension business Ceska Pojistovna. Hence, it has expertise that could benefit Nomos with its corporate banking background.
PPF and Nomos shareholders signed a memorandum of understanding in May 2007 with the original aim of establishing a joint venture, but instead PPF has become a substantial shareholder. “PPF doesn’t have any ambitions to control Nomos. It is looking at Nomos as part of an investment strategy,” says Yuri Lekarev, executive director of the international business division of Nomos.
“The policy of the bank is to limit exposure to any individual sector to a maximum of 10%,” says Mr Lekarev, in addressing another concern that international investors often have about Russian banks: that they are too exposed to individual sectors. “We are strong in gold mining but it accounts for only 5% of the loan book. It would be impossible not to work with the oil companies but this is not our strategic focus.”
As regards funding, Nomos, similarly to other Russian banks, has turned to the syndicated lending market during the liquidity crunch, when demand for bonds has been weak. “We don’t need to refinance any of our three outstanding Eurobonds until next year,” says Mr Lekarev. “Meanwhile, we are focusing on syndicated loans and trade finance [as funding sources].”
Central bank measures
“In Russia, there are not a lot of financial institutions that depend wholly on the international capital markets for funding,” says Mr Lekarev, adding that the central bank measures helped to ease the situation considerably. The measures included expanding the range of securities eligible for repo financing, allowing banks to borrow from the central bank against the pledge of loans, and lowering reserve requirements. In addition, the Russian finance ministry has been holding auctions to place budget cash on deposit with particular banks.
These kinds of measures show how far Russian technocrats have come in dealing with the day-to-day market challenges of Russian banks. Now they just need to concentrate as much energy on fixing the long-term problems.
